The central bank raised 2%! The RMB exchange rate plummeted and dived over 300 points

The People's Bank Of China (PBOC) recently made two monetary operations in seemingly opposite directions - a "downgrade" of the RMB and a "raise" of the foreign exchange rate. The former is to strengthen the cross-cycle regulation, the latter is to regulate the exchange rate.

The People's Bank of China (PBOC) website announced on December 9 that in order to strengthen the foreign exchange liquidity management of financial institutions, the PBOC has decided to increase the foreign exchange reserve requirement ratio of financial institutions by 2 percentage points from December 15, 2021, i.e. the foreign exchange reserve requirement ratio will be increased from the current 7% to 9%.

Once the news came out, the onshore and offshore RMB exchange rates dived in a straight line. The offshore yuan fell below the 6.38 mark against the U.S. dollar, dropping more than 350 points from the PBOC announcement to raise the foreign exchange deposit reserve ratio.

As the PBOC announced a full-scale downgrade, the yuan strengthened silently against the U.S. dollar. on the morning of Dec. 8, the onshore and offshore yuan surged higher hand in hand, both breaking through their May highs this year and hitting new highs since May 2018.

While the yuan is strong, the dollar index does not show weakness. In this regard, analysts said that since the second half of the year, China's strong export momentum does not change, resulting in a growing trade surplus, so that the foreign exchange market dollar supply is relatively excess, thus promoting the strengthening of the yuan exchange rate.

State Administration of Foreign Exchange data show that from January to October, the bank balance surplus of 196.5 billion U.S. dollars, an increase of 1.2 times over the same period last year. In the first three quarters of this year, a measure of the settlement rate of foreign exchange willingness, that is, the size of the customer to get foreign exchange after selling to the bank and the customer foreign exchange revenue ratio is 66.9%, this ratio rose 2 percentage points over the same period last year.

On the other hand, the RMB exchange rate appreciation too fast will erode the profit of foreign trade industry, the PBOC at this time also has the consideration of stabilizing foreign trade. The PBOC third quarter monetary policy implementation report pointed out that to strengthen the management of expectations, to maintain the basic stability of the RMB exchange rate at a reasonable balance level; guide enterprises and financial institutions to establish the concept of "risk-neutral", guide financial institutions based on the principle of real needs and risk-neutral principle to actively provide exchange rate hedging services for small and medium-sized enterprises, to reduce the cost of exchange rate hedging for small and medium-sized enterprises, strengthen their own foreign exchange business risk management, and maintain the stable and healthy development of the foreign exchange market. Reduce the cost of exchange rate hedging for small, medium and micro enterprises, strengthen their own foreign exchange business risk management, and maintain the stable and healthy development of the foreign exchange market.

According to the Securities Times, the factors supporting the independent strengthening of the RMB exchange rate are multiple. Wang Youxin, a senior researcher at the Bank of China Research Institute, said in an interview that since November, the U.S. dollar index has moved rapidly higher in anticipation of the Federal Reserve's tightening monetary policy, but the trend of the yuan has remained stable or even appreciated slightly during the same period, which mainly stems from the following factors.
1. Against the backdrop of deepening bottlenecks in overseas supply chains, China's export orders continued to increase, and the trade surplus and foreign exchange earnings remained at a high level, strongly supporting the RMB exchange rat.
2. Since last year, the investment and safe-haven attributes of the RMB have been highlighted. With the increased openness of China's financial market, foreign investors have been increasing their holdings of RMB equity and bond assets, especially with the emergence of new overseas variants of virulent strains, which has heated up the market's safe-haven sentiment and put the RMB in more favor.
3. High overseas inflation, while China's inflation remains at a low level, is also boosting the RMB to some extent from a purchasing power parity perspective.

Zhang Yu, chief macro analyst of Huachuang Securities, said that there are two factors to pay attention to in driving the strength of the RMB exchange rate against the trend.
1. The recent spot trading volume of the RMB against the US dollar has released significantly, and the trading sentiment has helped push the exchange rate stronger.
2. Due to the widening of the trade surplus, at the same time, the surplus of foreign-related receipts and payments on behalf of banks is simultaneously higher, and enterprises' willingness to settle foreign exchange has led to stronger demand for settlement of foreign exchange on behalf of banks.

According to Everbright Securities, the forces that have pushed the RMB exchange rate strongly upward since the epidemic come from three main sources: first, the uneven impact of the epidemic on the U.S. and Europe has pushed the U.S. dollar index trend downward; second, China's continued strong export growth has driven the expansion of the trade surplus, which in turn has led to the widening of the bank balance; third, under the influence of the epidemic, the U.S. monetary easing is stronger than the domestic one, leading to the widening of the Sino-U.S. spread to historical highs and the overabundance of U.S. dollar liquidity. The spread between the U.S. and China widened to a historical high and the dollar liquidity was too abundant.

In addition to these, the reasons for the strong RMB exchange rate include the continued positive full-caliber bank balance surplus, the short-term tightness of domestic interbank RMB liquidity, the decline in market expectations of a PBOC downgrade, and the easing of Sino-U.

Zhong Zhengsheng, chief economist at Ping An Securities, said: China's current account has been in surplus for years and the situation of international capital flow is positive. The stability of China's economy and strong export competitiveness under the new crown epidemic support the pivot of the RMB exchange rate.

According to Ming Ming, chief analyst of fixed income at CITIC Securities, investor confidence and risk appetite in the foreign exchange market have improved, and the attractiveness of RMB assets has increased, supporting the RMB exchange rate.

Xie Yaxuan, chief macro analyst at China Merchants Securities, said: The inflow of international capital changes the foreign exchange supply and demand situation and promotes the appreciation of the RMB exchange rate.

For the future trend of the RMB, professionals have pointed out that while the RMB exchange rate has strengthened, the motivation to push the exchange rate to depreciate back is also building up.

According to Everbright Securities, the triple factors driving the RMB exchange rate upward have begun to show signs of divergence, with the US dollar index showing a stabilizing and rebounding trend, China's export growth rate likely to continue its trend downward, and the degree of monetary easing in China and the US will tend to converge. Thus, the probability of further upward movement of the RMB exchange rate is no longer high, but the probability of significant downward movement in the short term is equally low. It is expected that the RMB exchange rate (USD to RMB), which has entered the topping phase, will remain in a two-way fluctuation in the range of 6.3-6.7 in the later stage.

According to Zhang Yu of Huachuang Securities, a big inflection point of RMB exchange rate is being formed: the continuous strengthening of RMB exchange rate after the epidemic may be approaching the end, and the RMB exchange rate will be easy to depreciate but difficult to rise next year.

According to Zhang Yu's explanation, the current RMB exchange rate needs to focus on the following three risks of devaluation.
1. The new US$50,000 domestic resident facilitated exchange quota refresh is generated early next year, which will cause some seasonal depreciation pressure on the RMB exchange rate from the historical pattern.
2. The Fed's attitude is gradually turning hawkish, opening a monetary policy tightening cycle, and federal funds futures are already pricing in the first rate hike in July 2022; at the same time, the difference in economic growth between China and the U.S. is narrowing, and the difference in real GDP growth between China and the U.S. next year may narrow to the smallest since 1989. In the three historical rounds of U.S.-China economic and currency divergence periods, the RMB retreat has tended to depreciate.
3. Capital inflows are also weakening support for the RMB exchange rate in 2022, with emerging market economies such as China already at risk of capital outflows and falling asset prices as the Federal Reserve enters a tightening cycle.